How about that tax refund?
Last year, about 75 percent of Americans who filed tax returns received a refund. The average amount of those refunds was around $2,800. While many say they will use that money responsibly, recent data shows much of it is used for splurges. How do you plan to spend your 2012 tax refund? Remember, even though it is 2013, your tax refund is for the year 2012.
How you say you will spend your tax refund
According to a survey released in February by TD Ameritrade, 47 percent of those expecting a tax refund planned to use it to beef up savings. Meanwhile, 44 percent claimed they would use it for debt reduction. Only about 15 percent admitted to plans to splurge their “windfall.”
How you actually spend your tax refund
However, no matter how noble their intentions, the report also found that even these self-proclaimed “responsible” taxpayers spend at least some of that money in a discretionary way – often more than they intended to.
Jonathan Parker, a professor of consumer finance at Northwestern University’s Kellogg School of Management, using bank records and other data, found that, “There’s still a significant spending [spike] among this group.”
How you should spend your tax refund
Alexa von Tobel, founder of financial-planning site LearnVest.com, said, “If you have debt, pay down debt; if you don’t have it, fund your emergency savings.” However, reducing debt comes first. Tobel went on to say that contributing to savings is futile if you are still accumulating a high percentage of interest on old credit card debt.
She added a good rule of thumb: “Anything you can’t remember what you spent it on [soon after spending it], isn’t a good idea.”
However, some experts suggest other sensible ways to earmark that money.
Mike Blehar, managing director and principal at Fort Pitt Capital Group, suggested making home improvements to increase property value. “If you’re going to spend it, take a look at your house. What have you been putting off?,” he asked. Perhaps the water heater could be upgraded. Perhaps insulated windows would lower energy costs. Work that makes your home more energy efficient may also qualify for a residential energy tax credit next year.
If your car is old and becoming a money trap just to keep it running, MSN suggests it might be wise to consider using that refund toward the down payment on a new rig. Greg McBride, a senior analyst at Bankrate.com, adds that banks are now offering record-low interest on new car loans, making the prospect all the more tantalizing.
When a big tax refund isn’t a good thing
If you do get a large refund, however, that is not always a good thing. According to Alexa von Tobel, founder of financial-planning site LearnVest.com, “What you’ve just done is given the government an interest-free loan.”
You may be withholding too much in taxes from your paychecks. By reducing your withholding to the optimal level, you will get more money in each paycheck and less in a lump sum refund after tax filing. That will mean more will be routed into your employer-based 401(K) or ROTH IRA on a regular basis. You can figure out your optimal withholding amount by using the calculator on the IRS website. To change your withholding status, you will have to submit a revised Form W-4 to your HR manager.
So how do you plan to spend your tax refund?